The Rationale for Exempting Nonprofit Organizations from Corporate Income Taxation*

Abstract

Although most types of nonprofit corporations have been exempted from the federal corporate income tax since that tax was first adopted, we continue to lack a clear rationale for the exemption. This was perhaps understandable and acceptable when the nonprofit sector was small and nonprofit organizations were engaged largely in activities of a traditionally charitable nature. Today, however, the nonprofit sector represents a substantial and growing share of the national economy. Large concentrations of nonprofits can be found in a number of vital and expanding service industries, including education, health care, research, the media, and the arts. Nonprofit firms now commonly provide goods and services in direct competition with profit-seeking firms, and in many cases increasingly resemble their for-profit competitors in their manner of organization and operation. The traditional criteria for applying the exemption are, as a result, being stretched beyond recognition, so that the absence of an underlying rationale for those criteria, and indeed for the exemption in general, is becoming increasingly conspicuous.